»5 Minute Wrap Up by Equitymaster

On This Day - 3 FEBRUARY 2011
Read this and you will certainly end up rich!

In this issue:
» 9% growth sustenance a challenge for India, says ADB
» A top short seller cautions about China
» Bill Gross comes down heavily on the US Fed
» Indian markets feeling the heat of shift in fund focus
» ...and more!!

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Richard Russell. The name may not ring a bell or two in India. But it certainly does in the US. The gentleman is not only a very famous investor but is also known as the grand old man of financial newsletters. He has undoubtedly penned many memorable articles over the years. But today we are going to discuss perhaps his most popular piece till date. In it, he has dispensed what we believe as one of the most important financial advice that a person can get. If closely adhered to, the advice can do wonders to one's wealth over the long term.

Imagine two investors A and B. We assume that investor B starts earning at the young age of 19 and decides to put aside Rs 20,000 every year till the time he turns 26. And that's it. He doesn't invest a penny afterwards. Now, let us consider investor A. Unlike B, investor A starts investing Rs 20,000 only after he turns 26. But does so dutifully every year till the time he reaches 65 years of age. Both of them are assumed to earn 10% per annum on their investments.

Now here comes the real shocker. We know that investor B has made only seven contributions while A has made around 40 contributions towards his portfolio. Despite this, you'd be amazed to know that B will end up with more money than A when both of them turn 65. In other words, while A's money has grown around 11 times, B has been able to grow its money a whopping 66 times.

The above example clearly highlights the magic that the process of compounding works on one's portfolio. Just by letting his money compound over a slightly more number of years, investor B was able to make more money than A even though he made far less number of contributions. And therein lies the biggest secret to becoming rich we believe. Investment returns over a long period are not dependant as much on the amount of money one puts aside. They are more a function of letting compounding work its magic by starting to invest as early as possible.

Has the magic of compounding shown its results in your investments? Share your views with us or you can also post comments on our Facebook page.

 Chart of the day
Oil is flaring up again. And what is causing this surge? Well, we believe it is mainly because of the riots that have broken out in Egypt. While Egypt may not be a big oil producer in itself, it certainly borders the most prolific oil producing regions in the world, the Middle East. Today's chart of the day shows countries with the world's largest oil reserves. As can be seen, three of the biggest holders of oil reserves lie in the Middle East. India, placed a lowly 21st is but a small speck on the chart.

Source: Rediff.com

Exactly a year ago we had introduced you to a man with uncanny ability to spot overvalued assets. He answers to the name of Jim Chanos. After pulling the plugs on the likes of Enron, Tyco International and most recently the US financial institutions, Chanos had sounded alarm on China's debt burden. In fact he then even accused China of cooking its books and faking its strong GDP numbers. The billionaire with an enviable track record in short selling has this time pointed at risks in China's real estate.

He believes that fixed investments that now account for 70% of the Chinese economy are now tied to its real estate. We are not surprised to know this given the excessive lending that Chinese banks have resorted to in the past year. But what is worrying is that Chanos predicts a burst in China's realty bubble anytime soon. One that could shrink growth in the world's fastest growing economy. In such a scenario, investors globally would look for safer options in emerging markets. And India could well be the haven if the regulators here keep a strict oversight on bubble like conditions across assets.

The Indian stock markets have witnessed volatility since the beginning of 2011. The markets are down by almost 14% since the beginning of the year. Several reasons can be identified for this fall. Stories of corruption. Runaway inflation. Higher interest rates. But one major reason has also been a shift in fund allocation by large fund houses. Many of these houses have shifted funds out of India to the export-oriented markets of Korea and Taiwan. These economies have seen a rebound in growth in recent times, making them attractive investment destinations. With the western markets in line to witness another sell-off maybe these funds would start shifting back there.

Whatever it is, the Indian markets are bearing the brunt of this shift in fund focus. But then the Indian markets were also the ones who witnessed the boom in prices when these funds were pouring money into India. That is the innate problem of foreign fund flows. When they go away, they lead to market falls.

What happens when you invest in a fixed deposit of a bank? You earn a 7-8% interest, right? But what happens is inflation is running at around 14-15%? The 'real' value of your interest is negative! What you earn from the bank is less than what you pay as increased prices of things like food, groceries, and clothes. Now imagine earning nothing on your bank deposit. We mean if the interest rate is at 0%!

This is exactly what is happening in the US right now. By keeping interest rates at near-zero, the US central bank is robbing today's savers to pay for tomorrow's prosperity (even that's not sure). In fact, if you were to believe Bill Gross, the chief of the world's biggest bond fund, he has criticized the Fed for its policies.

As he has written in his latest note, "A low or negative real interest rate for an 'extended period of time' is the most devilish of all policy tools. And the asset class holder that it affects, or better yet, infects, is the small saver and institutions such as insurance companies and pension funds."

This is criminal. But then, central banks are generally kept out from the boundaries of crime, even if it is done against the poor savers.

There is no doubt that India has grown at a furious pace since 2005. It has also recovered remarkably well from the global economic slowdown. But for the country's economy to grow at a sustained basis of 9% annually in the future, it will have to find its own growth model. For instance, despite such a strong growth displayed in the past, India essentially remains a poor country in per capita terms. Then again, infrastructure development leaves a lot to be desired.

The political will also seems to be lacking. Especially when it comes to implementing long term reforms. Indeed, if India's government is able to widen its scale of vision and plan well, it will go a long way in making sure that the country's growth stays on track. Further, the infrastructural activity that takes place has to be after careful planning. It must not be a haphazard attempt that will only provide incremental benefits. Unless, India does away with all such constraints, achieving a consistent 9% growth in the coming years will certainly prove to be a challenging task.

Meanwhile, continuing in its positive vein, the BSE benchmark Sensex was in extremely buoyant mood today and was trading higher by around 320 points at the time of writing. Aiding this gain was the heavyweight pack led by ICICI Bank, L&T and Reliance. While most other Asian indices also closed in the green today, Europe had opened on a mixed note.

 Today's investing mantra
"The important thing is to keep playing, to play against weak opponents and to play for big stakes." - Warren Buffett

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